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LAST MARCH, THE U.S. SENATE CONSIDered a proposal by Sen. John Kerry (D-Mass.) to raise the Corporate Average Fuel Economy (CAFE) standards for cars and light trucks by 50 percent. Kerry and other proponents of stricter standards had the support of a July 2001 report by the National Research Council (NRC) that called for significantly higher standards, as well as the backing of many major newspapers. The events of September 11 and the subsequent resurgence of violence and political uncertainty in the Mideast added to the momentum in favor of new fuel efficiency standards. But a coalition of Republicans and auto-state Democrats defeated the Kerry measure by a decisive and surprising 62-38 vote.

To the casual observer, the decision may have seemed a defeat of the public interest by special interests. In fact, it was a victory for economic common sense. As many economists and other policy experts have argued, the CAFE standards save very little gasoline, increase car buyers' costs and lower their benefits, increase pollution and auto fatalities, and shift revenue away from U.S. automakers to foreign firms. Instead of raising the fuel efficiency standards, policymakers would better address any externalities associated with gasoline by raising the gas tax.

A BRIEF HISTORY

The CAFE program, enacted in 1975, required all manufacturers selling more than 10,000 autos per year in the United States to have sales-weighted fuel economy of 19.0 miles per gallon in 1978. That meant that all of the new cars that an automaker sold had to average 19 mpg, though individual models could have gas mileages below that level. Under the law, the mileage standard increased to 27.5 mpg in 1985, and it currently remains at that level.

The CAFE law divides an automaker's cars into foreign and domestic fleets. It also offered a different standard for light trucks (pickup trucks, sport-utility vehicles, and minivans) -- a concession that seemed insignificant in 1975 because those vehicles comprised only a small percentage of the total number of vehicles on the road. However, that concession has become increasingly significant in recent years as light truck sales -- buoyed by the wildly popular sport-utility vehicle -- now comprise nearly half of all U.S. auto sales. The National Highway Transportation Safety Administration, using authority granted it through CAFE, currently requires a 20.7-mpg fleet-efficiency standard for light trucks, but the agency is considering raising that standard.

Compliance

If a manufacturer does not comply with the CAFE standards, it is subject to a civil fine of $55 per car/mpg. For example, if a manufacturer producers one million cars with a sales-weighted mpg of 26.5 mpg, that firm could be subject to a fine of $55 per car/mpg x 1 million cars x 1 mpg, or $55 million.

Foreign automakers view the fine as a tax. Thus, BMW and Mercedes-Benz, for example, have routinely paid CAFE fines. In contrast, American firms view the standards as binding because their lawyers have advised them that, if they violate CAFE, they would be liable for civil damages in stockholder suits. The fear of civil suit is so strong that even Chrysler, which is owned by the German firm Daimler-Benz, will not violate the limits. Because the "shadow tax" of the CAFE constraint (the cost of complying with the standards rather than paying the fine) can be much more than $55 per car/mpg, the effects of CAFE standards are much larger on U.S. automakers than foreign firms.

GASOLINE EXTERNALITIES

In a free market, consumers equate the price of a commodity (the "internal" cost) with the marginal value of its consumption. In the absence of any external costs like air pollution or traffic congestion, the marginal value of a gallon of gas to consumers equals its price. No public benefit would arise from reducing the consumption of gasoline, under that scenario. However, if external costs do exist, economic theory recommends that the appropriate policy response is to increase the price to consumers to equal the marginal cost of production plus the cost of the externality. …